I got a GREAT question from a client today: “Should I use Margin or Mark up?”
If you google margin vs. mark up, there’s a ton of information about what the calculations are and what they mean, but that doesn’t necessarily explain how it applies to your business or industry and what it means to YOU.
Mark up % refers to the % that you mark up your hard costs and is calculated by hard costs plus a % of hard costs:
Your hard costs are $100k
Your mark up is 20%
Your sales price will be $120k ($100k costs plus 20% of $100k)
The simplest way to calculate is $100k times 1.20
Your Gross Margin refers to the % of gross profit you earn on your sales and is calculated by dividing your gross profit by your sales:
Your sales are $120k
Your hard costs are $100k
Your Gross Profit is $20k
Your Gross Margin is 16.66% ($20k/$120k)
The simplest way to calculate is: Sales, less hard costs, divided by sales
Clear as mud? What does it mean and why does it matter?
Most contractors use a mark up % of hard costs to calculate their sales price, and this makes a lot of sense.
However, it’s good to know what that mark up translates to as a Gross Margin when analyzing your Profit and Loss Reports because it’s simpler to analyze from that perspective. Your Profit and Loss report is going to read like this:
Sales $120k
-COGS $100k
=Gross Profit $20k
It’s very simple to create a goal around your gross profit – what % do you need to make off of your sales/jobs in order to cover your overhead and make a profit? You know you need a certain amount of $ to do this. And, it’s very simple to calculate your gross margin by looking at your P&L. (gross profit divided by sales)
The reason it’s important to understand the difference is because, as you can see from the above example, a 20% mark up does not equate to a 20% gross margin!
Back to the question of “Should I use Margin or Mark up?”, that depends on how you price your jobs, but the most important thing is that you know and understand the difference. Most contractors price their jobs using mark-up and it makes sense, just make sure you know how that translates into margin so you can intelligently project your gross profit and analyze your Profit and Loss report.
If you are just looking at your job cost reports, and not analyzing your financial reports, (the Profit and Loss and Balance Sheet) you are missing out on the MOST critical information about the health and sustainability of your business.
I’m working on a series of articles to help contractors understand their financial reports, and this is just one piece of the puzzle, but an important thing to understand.
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